General July 19, 2020 2

What Is Debt?

What is debt meme

Hello Friends, I hope all is well with you! We are back to primetime blogging with another interesting topic – debt. Mr. Nahas, what is debt? Great question! That is what I will be answering for you today. Debt is how you buy things that you don’t have the full amount for.  If a house is $200,000 and you don’t have that amount, you will have to take a loan out in order to purchase the home.

Debt in General

Debt is something that is owed or due, usually money; there are usually two parties involved, the debtor and the creditor. The creditor is the one lending you money or whatever you agreed upon, and the debtor is the one that receives the money or whatever you agreed upon. The debtor must repay the creditor the original amount plus interest. The time frame must be agreed upon by the creditor and the debtor; it can be 30 minutes, 30 days, 30 weeks, 30 months, 30 years, or whatever is agreed upon.

Debt usually has these attributes:

  1. Principal Amount – The initial amount that is borrowed
  2. Interest Rate – This is determined by credit based on your credit score. The creditor will also specify if the interest is compounding or simple
  3. Term – This is the time period that the creditor wants the debt to be paid back. It could be days, weeks, months, or years
  4. Payment Due – This takes into consideration the principal amount, interest rate, and the term to get a specific payment due. Payments are usually due every month, but it just depends on the creditor and the agreement
  5. Total Cost – The total cost is the principal amount plus the interest you paid over the life of the debt

It’s also important to note that there is no major difference between a loan and debt; they are usually used interchangeably but both need to be paid off regardless. Additionally, the attributes above are not an exhaustive list, each loan has its own attributes and details that need to be considered. There are two main overall types of debt – secured and unsecured.

Secured Debt

Secured debt is debt that is backed by collateral. What this means is that you (the debtor) pledge some asset, usually physical, in exchange for the loan.  I think an example would help clarify it. For example, let’s say that you want to buy a house, you would need to go to the bank to get approved for a loan. In the terms of the loan, they will specify that the house you want to purchase will be the collateral so, in the event that you default on your house payment, the bank has the right to take away the home. This type of loan is less risky for the bank because there is a physical asset securing the loan; they can take your home if you fail to pay back the loan.

There are two main types of secured debt:

  1. Home Loans – This is a type of loan (debt) that you apply for when you want to purchase a piece of real estate but don’t have the full amount. The collateral for this type of loan is the house you want to purchase, so in case you default and can’t make the payments, the bank will attempt to take it away from you. I will go over home loans in more detail.
  2. Auto Loans – This is a type of loan that you apply for when you want to purchase a vehicle but can’t afford the full purchase price. You would apply for an auto loan; the collateral for this loan is the car you want to purchase. I will go over auto loans in more detail later on

Unsecured Debt

This type of debt is the opposite of secured debt. There is no collateral that is tied to the loan. This makes the loan riskier for the creditor as they cannot go after the collateral since there is none. The interest rate is higher on these types of debt to account for the risk that the creditor is taking by issuing you the loan.

The main types of unsecured debt are:

  1. Credit Cards – If you don’t know what credit cards are, they essentially are debt. They are a piece of plastic that is issued by banks or other companies to consumers, so that they can spend money that is not theirs. Credit cards can be considered a type of debt since you are using money that is not yours to pay for something that you need or want. You are using the bank or the issuer’s money to pay for stuff. Interest is high on these types of debt. This debt is unsecured and has no collateral, so the bank or issuer cannot go after the Gucci belt that you bought.
  2. Student Loans – This type of debt is used to pay for education related expenses. This type of loan is not secured by collateral; the lender cannot go after your degree or take it away from you if you default on the loan. If you would like more information on student loans or wondering how they work, visit my article on How Do Student Loans Work.
  3. Personal Loans – This type of debt is usually short-term and can be used to pay for anything like medical expenses, baby showers, to pay off other debt, etc. The interest rates on these loans are higher because they are unsecured.

Facts and Figures

I think it would be worth while to put some statistics on debt. I researched this data from the Federal Reserve’s website. All of this data is for 2020Q1 (Total of four quarters per year, Q1: Jan – Mar, Q2: May-June, Q3: July-Sep, Q4; Oct-Dec).

The debt numbers are scary. We are constantly reaching new all-time highs for household debt. People are borrowing and spending money they don’t have at an all-time high. The following numbers and visual were obtained from the Federal Reserve’s website.

Debt stats

 

Mortgage Debt $9.71 trillion
Home Equity Line of Credit $0.39 trillion
Student Loan Debt $1.54 trillion
Auto Debt $1.35 trillion
Credit Card Debt $0.39 trillion
Other Debt $0.43 trillion
Total Household Debt $14.3 trillion

I hope that I provided you all with useful information on what debt is and the different types of debt. Playing with debt is a dangerous game, it has the possibility to destroy your livelihood if you use it irresponsibly but if you learn how to use it the right way, it offers you the chance to invest in some assets that can build you wealth. Be smart about debt and don’t let it destroy your wealth. If you have any questions or need me to clarify anything, post a comment and I will reach out to you as soon as I can. Thank you, friends, for stopping by! Take care and see you soon!

 

Peace Out,

Mr. Nahas

P.S. Don’t forget to like, comment, subscribe to my email list, and to share this so I am able to help as many people as possible!

 

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Mr. NahasFinance:

2 Comments

  1. ceridwensilverhart

    July 24, 2020
    Reply

    Yikes, that graph is scary when you think about the impact debt can have on a person's life!

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